High Yield Bonds Flashcards
Given the initial yield and the default loss rate, how do you calculate the return?
Initial Yield - Default Loss Rate = Return
Given the following, how do you calculate the return:
- US Treasury Yield
- Spread vs Treasuries
- Default Rate
- Recovery Rate
(US Treasury yield + Spread vs. Treasuries) – (Default rate + Recovery rate) = Return
What does the spread mean?
The spread is a risk premium.
When are high-yield bonds cheap?
When the yields are high
How do high yield returns compared to investment grade returns?
Investment Grade (1% - 3%)
High Yield (-2% - 12%)
so high yield has a large window of possible returns
What is the correlation between price and effective duration for a high yield bond?
low correlation
What is a fallen angel?
A fallen angel is a bond that was rated investment-grade but has since been downgraded to junk status due to the declining financial position of its issuer. The bond is downgraded by one or more of the big three rating services – Fitch, Moody’s and Standard & Poor’s (S&P).
Why are fallen angels preferred over average high yield bonds?
They are considered higher-quality bonds than the average high yield bonds, as they have the potential of bouncing back to investment grade. Fallen angel issuers are usually larger, more mature companies with well-known brand names.
What is LGD (loss given default)?
Returns are influenced not only by probability of default (PD) but also by loss given default (LGD). LGD equals PD minus the recovery rate. Reflecting the rule of absolute priority, recoveries generally decline with each step down in the capital structure.
What are the two main categories of ratings for debt?
- Below investment grade
- Investment grade
What does high yield debt mean?
Category of debt provides a high rate of return to compensate for greater credit risk
What does a secondary market refer to?
Market for existing debt
What does a primary market refer to?
A primary market refers to the market for new issues and stands
What is a leverage buyout?
a buyout – or acquisition of a controlling interest in a company – facilitated primarily with leverage, which is another word for debt
How does a leverage buyout work?
The premise of an LBO is to maximize high yield debt borrowings to finance an acquisition. By doing this, a private equity firm minimizes its equity investment while retaining all the benefits of growth. This happens because debt borrowings only obtain a fixed rate of return – principal and interest – while the equity retains all residual enterprise value.
